Should Greece leave the Eurozone? This column argues that aggressive restructuring of Greek debt within the Eurozone, rather than departure, is the best option.
Glance at the headlines and you would think that Greek withdrawal from the Euro is a mere formality. Plans are being drawn up, we are told, by responsible policymakers and businessmen. Hedge funds have laid on their bets. Speculation has moved on to whether Greece’s exit will mark the end of the euro. This takes self-fulfilling prophecies to a new level. Greek departure from the Eurozone is a possibility, but is far from inevitable. Departure from the euro worsens the economic problems facing Greece and Europe and so if those who will make the decision are immune from bubbling nationalism, they will opt against it (see Xafa 2012). Aggressive restructuring of Greek debt within the Eurozone, not departure, is the best path. A path made more possible now that Greek austerity is delivering a budget surplus before interest payments.
Outside of Greece, most believe the root of the problem is that Greeks are overpaid, undertaxed and over-indulged by state benefits. Foreigners are always too much of this or too little of that, but even if these opinions were right, such issues of labour productivity, fiscal legitimacy, and financial responsibility, could never be solved by the re-adoption and devaluation of a local currency. Devaluations serve to keep the current show on the road by temporarily devaluing local wages and savings against those overseas. Just before joining the euro, Greece devalued the drachma versus the deutschmark by 14%, the last in a long string of devaluations, but that competitive boost, like those before it, did not last. Arguably the way to deal with such fundamental issues is to tie the macroeconomy to an anchor of value and focus on sorting out labour and tax reforms which, it is often argued, German Chancellor Schröder successfully managed a decade ago, helping to explain Germany’s competitiveness today.
Uncontroversially, re-adoption and devaluation of the drachma would cause the value of Greece’s debt as a percentage of GDP, already at 160%, to soar, probably doubling or trebling, as this €356 billion of debt promises to be repaid in euros. Any devaluation would have to be followed by a default. It is a hopeless and useless strategy proposed by those enjoying Schadenfreude at the Eurozone’s difficulties. Greece looks insolvent. Pelting liquidity at it will not help. Greece should therefore restructure its debt. Lifting the pressure on reforming productivity, taxation and state benefits by devaluing would be neither sufficient nor necessary.
Outright default is no panacea either. Indeed, the best argument for a re-adoption of the drachma is not that it would boost Greece’s exports of shipping charters – which are priced in dollars anyway – but that default would cause great harm to Greek banks and Greek savers who own the greatest proportion of Greek Government bonds. They would be wiped out by an outright default. Converting their assets and liabilities into drachmas, like the pesofication of deposits in 2000 in Argentina, might keep Greek savers and banks afloat, if angrier and poorer. But debt restructuring comes in many different flavours and can also preserve the hope of eventual repayment, thereby avoiding insolvencies. Greek assets may have been overvalued during the past decade, but they are worth something.
One example of an aggressive restructuring would be for Greece to announce that it is swapping all of its outstanding debt with a 20-year, euro-denominated bond that would pay a 0.50% interest rate. This would transfer the value of the market write down of Greek debt to the benefit of Greece and not just to those betting against it. In so doing it would remove the demands for austerity of self-defeating proportions. But above all else, by arriving at a fiscally-sustainable position without need for devaluation, default or exit, this would allow us to all move on. It would reduce the uncertainty that is paralysing the world economy. Despite the recent, gratuitous downgrade by the credit rating agencies to A+, Japan comfortably affords a debt to GDP ratio of over 220% because of its near-zero interest costs.
Ultimately a once-and-for-all debt restructuring will boost Europe’s financial institutions, but initially they will baulk at the write-downs. The practical reality is that full repayment is not an option. Affordability of interest and removal of debt roll-over risks would mean that the write downs would be limited, perhaps no greater than that already implied by current market valuations. Savers would be left with a marketable and valuable asset.
Aggressive debt restructuring would cause market discipline, notable by its absence before the crisis, to return with vengeance. Greek governments and those elsewhere would have to run a tight ship or face onerous levels of interest costs on future deficits. That would be no bad thing for the future of the Eurozone. But getting in the way of practical solutions is the political demand for nation to triumph over nation and extract punishment and penalty. Economic reparations on the defeated have been part of European history for over 2,000 years. If the euro is to have any future, these primeval urges have to be confined to the football pitch.
Xafa, Miranda (2012), “Greece’s exit from the Eurozone would be all pain, no gain”, VoxEU.org, 18 March.